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Penis envy in Freudian psychoanalysis refers to the theorized reaction of a girl during her psychosexual development to the realization that she does not have a penis. Freud considered this realization a defining moment in the development of gender and sexual identity for women — the parallel reaction in boys to the realization that women do not have a penis being castration anxiety. Freud's theories regarding psychosexual development, and in particular the phallic stage, were rejected, criticized or challenged by other psychoanalysts, such as Karen Horney, Otto Fenichel and Ernest Jones, Erik Erikson, Jean Piaget, Juliet Mitchell and philosophers or sociologists such as Clara Thompson, Betty Friedan, Luce Irigaray, Julia Kristeva, Hélène Cixous.
In contemporary culture, the term sometimes refers inexactly or metaphorically to women who are presumed to wish they were men.
The psychoanalytical concept of penis envy is unrelated to "small penis syndrome" which is anxiety caused by the belief one's penis is too small (though Otto Fenichel did explore the possibility of a boy's envy for the adult [paternal] penis).
Freud introduced his theory of the concept of interest in—and envy of—the penis in his 1908 article "On the Sexual Theories of Children": it was not mentioned in the first edition of Freud's earlier Three Contributions to the Theory of Sex (1905), but a synopsis of the 1908 article was added to the third edition in 1915. In On Narcissism (1914) he described how some women develop a masculine ideal as "a survival of the boyish nature that they themselves once possessed". The term grew in significance as Freud gradually refined his views of sexuality, coming to describe a mental process he believed occurred as one went from the phallic stage to the latency stage (see Psychosexual development).
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In Freud's psychosexual development theory, the phallic stage (approximately between the ages of 3.5 and 6) is the first period of development in which the libidinal focus is primarily on the genital area. Prior to this stage, the libido (broadly defined by Freud as the primary motivating energy force within the mind) focuses on other physiological areas. For instance, in the oral stage, in the first 12 to 18 months of life, libidinal needs concentrate on the desire to eat, sleep, suck and bite. The theory suggests that the penis becomes the organ of principal interest to both sexes in the phallic stage. This becomes the catalyst for a series of pivotal events in psychosexual development. These events, known as the Oedipus complex for boys, and the Electra complex for girls, result in significantly different outcomes for each gender because of differences in anatomy.
Freud thought girls:
A similar process occurs in boys of the same age as they pass through the phallic stage of development; the key differences being that the focus of sexual impulses need not switch from mother to father, and that the fear of castration (castration anxiety) remains. The boy desires his mother, and identifies with his father, whom he sees as having the object of his sexual impulses. Furthermore, the boy's father, being the powerful aggressor of the family unit, is sufficiently menacing that the boy employs the defense mechanism of displacement to shift the object of his sexual desires from his mother to women in general.
Freud thought this series of events occurred prior to the development of a wider sense of sexual identity, and was required for an individual to continue to enter into his or her gender role.
Freud considered that in normal female development penis envy transformed into the wish for a man and/or a baby.
The former were dominated by fantasies of having or becoming a penis—as with the singing/dancing/performing women who felt that in their acts they magically incorporated the [parental] phallus.
The latter sought revenge on the male through humiliation or deprivation (whether by removing the man from the penis or the penis from the man).
Freud's theories regarding psychosexual development, and in particular the phallic stage, were early challenged by other psychoanalysts, such as Karen Horney, Otto Fenichel and Ernest Jones, though Freud did not accept their view of penis envy as a secondary, rather than a primary, female reaction. Later psychologists such as Erik Erikson and Jean Piaget would challenge the Freudian model of child psychological development as a whole.
Jacques Lacan however would take up and develop Freud's theory of the importance of what he called "penisneid in the unconscious of women" in linguistic terms, seeing what he called the phallus as the privileged signifier of humanity's subordination to language: "the phallus (by virtue of which the unconscious is language)".
He thereby opened up a new field of debate around phallogocentrism—some figures like Juliet Mitchell endorsing a view of penis envy which "uses, not the man, but the phallus to which the man has to lay claim, as its key term", others strongly repudiating it.
A significant number of feminists have been highly critical of penis envy theory as a concept and psychoanalysis as a discipline, arguing that the assumptions and approaches of the psychoanalytic project are profoundly patriarchal, anti-feminist, and misogynistic and represent women as broken or deficient men. Karen Horney—a German psychoanalyst who also placed great emphasis on childhood experiences in psychological development—was a particular advocate of this view. She asserted the concept of "womb envy" as an emotional reaction to the idea of penis envy, and saw "masculine narcissism" as underlying the mainstream Freudian view.
In her influential paper "Women and Penis Envy" (1943), Clara Thompson reformulated the latter as social envy for the trappings of the (then) dominant gender, a sociological response to female subordination under patriarchy.
Betty Friedan referred to penis envy as a purely parasitic social bias typical of Victorianism and particularly of Freud's own biography, and showed how the concept played a key role in discrediting alternative notions of femininity in the early to mid twentieth century: "Because Freud’s followers could only see woman in the image defined by Freud – inferior, childish, helpless, with no possibility of happiness unless she adjusted to being man’s passive object – they wanted to help women get rid of their suppressed envy, their neurotic desire to be equal. They wanted to help women find sexual fulfilment as women, by affirming their natural inferiority". 
A small but influential number of Feminist philosophers, working in Psychoanalytic feminism, and including Luce Irigaray, Julia Kristeva, and Hélène Cixous, have taken varying post-structuralist views on the question, inspired or at least challenged by figures such as Jacques Lacan and Jacques Derrida.
Juliet Mitchell in her early work attempted to reconcile Freud's thoughts on psychosexual development with Feminism and Marxism by declaring his theories to be simply observations of gender identity under capitalism.
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